House passage of the big reconciliation bill is a welcome development for the millions of Main Street job creators otherwise facing a massive tax hike next year. S-Corp enthusiastically supports the measure, but one question remains — why does a bill designed to prevent tax hikes on small and family-owned businesses raise taxes on many of those businesses instead?
To recap – the House-passed bill would limit SALT deductions for millions of pass-through business owners of so-called Specified Service Trade or Businesses (SSTBs), imposing an $80 billion tax hike on these businesses even as the C corporation down the street continues to deduct all its SALT payments. Compared to what those businesses will pay this year (or pre-TCJA) that’s a tax hike beginning in 2025.
S-Corp opposed the SSTB designation when it was used to limit the Section 199A deduction back in 2017, and we really hate it now that it’s being used to limit SALT deductions as well.
Turns out we’re not alone. The Tax Foundation is out with a new analysis of the provision. Key take-aways include:
Economic Impact of Eliminating PTET Workarounds: The analysis estimates that disallowing SALT deduction cap workarounds for Specified Service Trades or Businesses (SSTBs) would reduce GDP by 0.2% and the capital stock by 0.3%. This suggests that the removal of PTET mechanisms could have a negative effect on the broader economy.
Concerns About Tax Neutrality: The Tax Foundation also notes that disallowing PTETs only for some pass-through entities diverges from the principle of tax neutrality by creating substantially differential tax treatment for various types of pass-through entities. This could lead to inefficiencies and distortions in business decision-making
Implications for High-Tax States: In high-tax states like New York, the elimination of PTET workarounds could significantly increase the federal tax burden on certain businesses. For instance, the removal of PTETs could result in New York businesses paying an additional $5 to $6 billion in federal taxes, with some New York City firms facing a 50% tax hike due to the loss of deductions, such as the city’s 4% unincorporated business tax.
Conclusion: Under the proposed changes, while C corporations and some pass-through businesses would still be able to treat taxes as a deductible business cost, many other pass-through businesses would not — non-neutral treatment that benefits some industries and business formations over others, and which comes at an economic cost. Our analysis highlights the implications of removing PTET mechanisms, especially for pass-through entities operating in high-tax jurisdictions.
Next up is the AICPA letter to congressional tax-writers raising a series of concerns about the House-passed bill, including strong opposition to the SSTB SALT carve-out:
The AICPA urges Congress to retain the entity level deductibility of state and local taxes for all pass-through entities. The One, Big, Beautiful Bill Act as proposed unfairly targets specified service trades or businesses (SSTBs) (as defined under section 199A(d)(3)) by preventing SSTBs from deducting state and local income taxes and, therefore, further needlessly widening the parity gap among (i) SSTBs and (ii) non-SSTBs and C corporations.
This proposed bill would leave SSTBs in an even worse position than pre-TCJA by prohibiting SSTBs from deducting local taxes, which had been a permissible deduction before the enactment of TCJA. Aside from simply preventing SSTBs from claiming any deduction for state and local taxes, this bill would introduce significant complexity and uncertainty in the proposed “qualifying entity” test, the “state and local tax allocation mismatch” rules of proposed section 6659, and the “substitute payment” limitation. The changes to section 164 and section 275 should be clear, avoid double-negatives, and put more emphasis on the treatment of common taxes of all businesses, such as income, gross receipts, sales and use, property, and excise taxes.
Finally, a national survey conducted by the Winston Group shows voters are highly skeptical of the House approach and support tax parity over efforts to single out pass-throughs with new tax burdens.
Voters were asked about the House bill’s proposal to limit the ability of pass-through businesses to fully deduct their state and local tax (SALT) expenses:
Overall, 68 percent favor the idea of allowing small and family-owned businesses to deduct the cost of state, local and property taxes as a business expense from their federal taxes (68-13 favor-oppose). Strong majorities of conservative Republicans (70-11), Republicans overall (71-11) and independents (63-16) are also in favor.
One of the most striking findings: 82 percent of voters believe that small and family-owned businesses should receive the same treatment as corporations when it comes to deducting state and local taxes.
Voters also recognize that eliminating this deduction would amount to a tax increase on the very businesses that employ most American workers. Nearly two-thirds of respondents said ending the deduction would “put more [businesses] out of business.” And 71 percent said small businesses should be using that tax revenue for wages and benefits, not handing it over to Washington.
The goal of the reconciliation bill is to make permanent the tax benefits of the 2017 Tax Cuts and Jobs Act for families and Main Street businesses. These businesses employ a large majority of American workers. In recent years they’ve weathered the pandemic, supply-chain disruptions, inflation, labor shortages, and interest rate hikes. Now is the time to support them, not single them out. Rolling back SALT Parity for Main Street businesses is bad policy, bed economics, and bad politics.